Commodity FX: Growth constraints cap carry – BNY

BNY’s Geoff Yu highlights that a less aggressive Federal Reserve has weakened the US Dollar but hasn't generated a sustained increase in commodity foreign exchange rates. High nominal interest rates in Australia and Norway are tempered by stagflation and productivity challenges, while South Africa's policy approach emphasizes global growth over carry.

Even before recent employment data, inward foreign exchange flows showed a rise in dollar hedges. The market is anticipating a mean reversion in dollar hedges, which was likely overdue. The Federal Reserve's decision and its impact on market credibility have hastened this trend. While gold has seen significant action, there have been no indications of a broader commodity rally to revive the "debasement" trade that dominated markets in January and February.

In the short term, only a few commodity currencies—Norwegian Krone, Australian Dollar, and an emerging market basket comprising Chilean Peso, South African Rand, and Brazilian Real—are showing net buying interest. Over the past week, aggregate flows have returned to net selling. The Reserve Bank of Australia and Norges Bank maintain the highest interest rates among G10 countries, but there are unique risks that prevent a robust forward real-rate gap compared to the USD.

As the Iran conflict stabilizes, commodity-linked economies are more inclined to return to earlier easing paths, thereby preventing further widening of real rates. South Africa, for instance, surprised markets by maintaining its July rate hike and adopting a forward-looking stance, signaling a potential policy adjustment based on weaker inflation expectations.

The global growth focus is creating a ceiling for carry performance unless the Fed signals rate cuts. Investors should avoid rushing into the weaker-dollar commodity trade and should maintain selective exposure to commodity FX and emerging market duration until broader growth recovery is confirmed, not just easing expectations from the Federal Reserve.